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By Clifford Rossi

Newswise — Since the November 2024 presidential election, one of the biggest questions for mortgage market observers was whether the Trump Administration would reboot , the giants of the mortgage finance system that have enabled the US housing market to flourish since their introduction. Privatization of both government-sponsored enterprises (the Enterprises) would be a heavy lift, however, merging both Enterprises now would have many benefits.

Privatization: The Long and Winding Road

Unfortunately, Fannie and Freddie remain the last vestiges of the 2008 Global Financial Crisis (GFC), languishing today in a state of regulatory limbo via conservatorship; neither able to operate as a government agency or private corporation, but a murky blend of both.  Privatizing Fannie and Freddie would be a heavy lift from a capital markets perspective. With a combined 2024 net worth of about for both companies, an IPO to raise capital for the release of both companies would likely be the largest in history.  Beyond that issue looms what to do about the issued to the US Treasury in return for a capital infusion of the Enterprises during the financial crisis. 

To allow Fannie and Freddie to increase their capital levels, a modification was made to the preferred stock agreements to permit dividends that would otherwise be sent to the Treasury to remain with the Enterprises. Unwinding all of this will be a major but not insurmountable hurdle on the path to privatization.  The complexity of privatization, however, is rivaled only by the sensitivity of the mortgage market to any perceived or real disruption as a part of a privatization effort.  Any jolt to the secondary market for mortgage-backed securities could create an economic heart attack that reverberates beyond the mortgage market.  Privatization is eventually the right course of action, however, merging Fannie and Freddie should precede privatization and could begin now with less peril to markets.

The Case for Merging the Enterprises

The origin story for Fannie and Freddie is much like that of our banking system, a disjointed set of institutions established over time in different markets that were never intended for today’s housing finance system.  Fannie was born out of the Great Depression and catered to commercial banks, while Freddie came along decades later and initially served the thrift industry.  As part of the response to the , Freddie Mac was spun out as a separate entity that would bring competition between both companies for mortgages sold by banks, thrifts and other mortgage originators.  The idea of competition was sensible at the time, however, a weak regulator (The Office of Federal Housing Enterprise Oversight, OFHEO) together with a booming mortgage market became a recipe for excessive competition for both Enterprises. Both companies effectively compete on price, product and service.  In the years leading up to the GFC, Fannie and Freddie introduced automated underwriting systems and streamlined the collateral valuation processes that helped power the huge loan volumes that would feed the unsatiable appetite for MBS from investors around the world.

To accommodate the demand for MBS, Fannie and Freddie pulled the risk lever. As time went on, there wasn’t much daylight between Fannie and Freddie when it came to product and service.  Fannie and Freddie eventually created mortgage products that were riskier than the plain vanilla mortgages that had historically been bought by the companies.  Which brings us to price.

Both companies charge a guarantee fee (gfee) to compensate them for the credit risk they take on mortgages.  In the years preceding the GFC, originators with large market shares could play one GSE off the other and force lower gfees on Fannie and Freddie.  It would turn out that in the fierce competition over market share, the GSEs ultimately caused their own demise in a race to the bottom. Those lower gfees would not be able to cover the credit losses on the higher risk products taken in by Fannie and Freddie, particularly in 2005-2007. Competing on price in this case was a fool’s errand and points to an inherent flaw in the current duopolistic model that needs to be addressed in advance of any recapitalization and release from conservatorship.

Operating in conservatorship is nothing like what Fannie and Freddie would experience in a post-conservatorship world. Seventeen years removed from when both companies were placed into conservatorship there are few employees now at both companies that remember what business was like before 2008.  A post-conservatorship environment with two nearly identical companies vying for the same mortgages invites another risk-driven event in the future.  It’s simply a matter of time when you have no other mechanism to compete on but price and credit risk.

Now with the introduction of the where both companies issue a common MBS security instrument, there is basically no practical difference between the firms.  Effectively the conventional mortgage market has two financial market utilities that back the credit risk on those loans and securitizes them.  Why do we need two?  We have one credit investor for FHA loans and one agency (Ginnie Mae) that supports the government MBS market.  A single Enterprise could easily support the conventional mortgage market without creating any panic in markets and would set up a less complicated privatization process in the end.

Beyond those benefits, there’s also an efficiency play that should appeal to the current Administration. Both companies combined have about 15,000 employees.  Combined G&A costs at these companies amounted to $6.5B in 2024. And both companies have nearly identical business lines, Single-Family, Multifamily and Capital markets.  With no real difference in the type of security issued or in price, product or service, or in business model, why should they be allowed to stay separate?

The new FHFA director may already have tipped his hand by placing himself as at both Enterprises, a bold and unprecedented move for sure.  And the certainly leaves the door open for simply combining both companies. This would be a natural next step in preparing the firms and the market for privatization.

Parting Thoughts

The innovation of a secondary mortgage market featuring Fannie Mae and Freddie Mac placed the US housing market in a position as being the envy of the world.  It expanded homeownership while keeping a lid on affordability and enabled mortgage markets to remain relatively stable for decades.  The GFC, however, revealed the hidden flaw of the GSE duopoly that competitive market forces would at some point devolve into a race to the bottom on credit.  Merging both Fannie and Freddie eliminate that problem, reduce operational costs to both companies as well as to mortgage originators and servicers that would no longer need to manage duplicative policies, systems and practices. The road to privatization runs through the merger of Fannie and Freddie.

Clifford Rossi (PhD) is Academic Director of the Smith Enterprise Risk Consortium at the University of Maryland (UMD) and Professor of the Practice and Executive-in-Residence at UMD’s Robert H. Smith School of Business. Before joining academia, he spent 25-plus years in the financial sector, as both a C-level risk executive at several top financial institutions including Fannie Mae and Freddie Mac and a federal banking regulator. He is the former Managing Director and CRO of Citigroup’s Consumer Lending Group.